The Return Premiums to Accruals Quality

• In Event: Earnings Quality, Earnings Management, and Accruals

Abstract

We find a strong and long-lasting negative relation between future returns and the Dechow and Dichev (2002) type accruals-quality measures (AQ), which are the standard deviation of residuals from current accruals regressed on cash flows. In decile portfolios that rank on AQ, a hedge portfolio that goes long in the lowest decile and short in the highest decile generates an annualized, risk-adjusted return of 4–12% over one-month to five-year horizons, depending on the AQ measure and the portfolio weighting scheme. The return premiums associated with AQ are, i) robust to a wide range of AQ measures, ii) robust to a battery of return-informative variables, and iii) not driven by low-priced or small stocks, earnings shocks, or the fourth quarter effect. The documented premiums are consistent with the information uncertainty effect where firm uncertainty is negatively related to future returns.

Authors

• Sati Bandyopadhyay, University of Waterloo

• Alan Huang, University of Waterloo

• Jialin Sun, St John's University

• Tony Wirjanto, University of Waterloo